The Limited Usefulness of Shared-Equity Mortgages

I’d be delighted if someone would explain to me why we aren’t talking more seriously about shared equity home mortgages in the U.S.

The answer is very simple, I think: the perceived cost to the borrower of a shared equity mortgage is much greater than the perceived benefit to the lender.

The Fannie Mae foundation put out a paper on these mortgages last year, which looked at attitudes towards them:

Survey results suggested also that most renters saw

the SEM as a form of bridge finance that they would try

hard to pay off in the relatively short term.

At the same time, it’s hard to see any bank regulator — or bank, for that matter — considering the equity part of these mortgages to be a remotely valuable asset. It has no maturity date, it’s completely illiquid, it can’t be called, there’s no secondary market in it, and it’s fraught with moral hazard: sellers have every incentive to negotiate a low up-front price for their home and receive value from the buyer in other ways.

I’m reminded of the oil warrants and GDP warrants which were occasionally attached to emerging-market sovereign bonds in the 1990s. They often ended up costing the borrower a lot of money, but investors almost never assigned any value to them until they were very much in the money and paying out.

The most important reason why shared-equity mortgages aren’t going to be a big thing, however, is simply that they’re too small. They’re generally for about 20% of the value of the home — they’re a way of figuring something out at the margin, but not a useful way of (re)structuring an entire loan.

In an ideal world of efficient markets, renters would take some extra money which they have available for mortgage payments, and invest that money in a liquid, securitized tranche of shared-equity mortgages, which would allow their slowly-growing down payment to keep pace with local house prices. But we’re now in a world of very inefficient markets, and interest in such products is likely to be zero for the foreseeable future. Which is why they’re not going to be part of the solution to the mortgage mess.